EuropeWill soft inflation hold back the ECB?

Eurozone inflation held steady at 1.5% in September, below the European Central Bank (ECB) target of just under 2%.

The European Central Bank is pictured (DDP)

Still-subdued inflation might suggest the need to proceed cautiously, and last week ECB Chief Economist Peter Praet said the central bank should discuss “recalibration” rather than an end to stimulus at its next meeting. But UBS Chief Investment Office (CIO) doesn't believe current levels of inflation, which have been held down by the resurgent euro, will deter the ECB from announcing a policy change in October:

• The euro’s rise this year is primarily a reflection of economic strength. It should act as a headwind in the coming quarters, but with only a moderate impact on GDP. We forecast growth to fall from 2% this year to a still solid 1.6% in 2018.

• Softer inflation is not entirely unexpected, and should decline through winter due to energy base effects. Since the decline is temporary, we think the ECB is likely to look through this, even if inflation dips below 1%.

• The ECB has shown it’s not afraid to talk down the euro when the currency rises strongly. A more hawkish Fed could also support the dollar, taking some pressure off the European currency.

So CIO's base case remains that in October the ECB will announce an extension to its monthly bond purchase program, although at a slower pace. The European economy is in its best shape since the global financial crisis, setting the scene for a gradual reduction in quantitative easing. Within Europe, CIO favors Eurozone equities over UK stocks.